Because seasonality persists, it registers in social memory. Calendar seasonalities are the most significant. There has been a lot of work on the almanac tendencies, starting from the Yale Hirsch November-April cycles, to January effect, and October declines (September 8, 2008). For us seasonalities are an essential starting point to understanding the element of market timing.
Since there are different risk profiles, different holding periods, different moods and confidence levels, there is a different level of belief among market participants regarding market seasonality. The market participants who find market seasonality subjective might be holding portfolios for more than 24-36 months. Their investment approach could be more about stock selection. So what happens during a certain May month, in a certain year might be less relevant.
Seasonalities could be assumed to be still a technician's domain and novel ground for technicians-turned-money managers who look at models such seasonalities, but that's not true. At the recent Market Technicians Toronto Chapter meeting, I met Don Vialoux, who manages a $100-million ETF fund. According to Vialoux, one should enter the North American equity market on October 28 and leave it at the close on May 5. Don believes in the old adage, "Sell in May and go away". If you change the city from Toronto to New York, there is another veteran telling you about how before it was "Sell in May and go away, it was, Buy in May and make some hay".
There seems to be a clear disconnect about what works or what does not. Even old adages can reverse in polarity in time. Well how strange is that? Behavioral finance would call it pattern seeking.
Sam Stovall, chief investment strategist, S&P, explains and questions the old adage in his book 'Seven Rules on Wall Street'. According to Stovall, "No matter whether you look back to 1990, 1970, 1945, or 1929, the seasonality has held" but then why is it not such a good idea to "Sell in May and go away"?
Stovall illustrates how vacation and tanning takes over and overrules portfolio selection and management seasonally. He also explains how the September-October negativity subdues prices on an average and that prices bounce off during the Nov-April period. This is one reason May-Oct period looks bland and weak.
"However the average advance of 1.1 per cent during the May-October period and transaction costs could dissuade a normal investor to sell off during the respective period. Getting out of the market could also leave the investor incapable to profit from a summer time surge. These considerations might make me suggest that investors ignore this rule rather than embrace it."
November to April is dominated by cyclical sectors viz. Financials, Industrials and Materials. The non-cyclicals, that is defensives (food, beverage and pharma) do better in the May-October period. Stovall suggests that this approach of going defensive (staples and health care) during the May-October period beat the S&P 500 by 4 per cent annualised. This rotation strategy also beat the market 61 per cent of the time by being in health care and 67 per cent of the time by being in staples.
Sector rotation enhances alpha and rides over the May bump. This is another reason why India needs sector Indices and Sector ETFs, which can not only smooth over annual seasonal perspective but also manage risk better. Investments are all about selection and allocation. And underneath the old adage market seasonalities rest sector-based seasonalities followed by regional, asset-specific and company-specific earning seasonalities. What we need are systems that can identify assets to buy and assets to sell in May.
The author is CMT and founder, Orpheus CAPITALS, a global alternative research firm
